Post on 18-Oct-2019
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy
International Finance
7e édition
Christophe Boucher
christophe.boucher@u-paris10.fr
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy
Session 7
7e édition
Exchange rate regimes and
monetary policy spillovers
2
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Roadmap
3
1. Classifying countries by exchange rate regime
2. Advantages of fixed rates/floating rates
3. Which regime dominates?
4. From the Trilemma to the dilemma?
5. The pseudo “currency war”
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
• Continuum of exchange rate regimes: From flexible to rigid
XX
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FLEXIBLE CORNER
1) Free float 2) Managed float
INTERMEDIATE REGIMES
3) Target zone/band 4) Basket peg
5) Crawling peg 6) Adjustable peg
FIXED CORNER
7) Currency board 8) Dollarization
9) Monetary union
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Trends in distribution of EM exchange rate regimes
• 1973-1985 – Many abandoned fixed exchange rates
• 1986-94 – Exchange rate-based stabilization programs
• 1990s -- Corners Hypothesis: countries move to either hard peg
or free float
• Since 2001 -- The rise of the “managed float” category.
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016 6
Distribution of Exchange Rate Regimes in Emerging Markets,
1980-2011 (percent of total)
Ghosh, Ostry & Qureshi, 2013, “Exchange Rate Management and Crisis Susceptibility: A
Reassessment,” IMF ARC , Nov.
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
De jure vs De facto
• Distinction between what countries declare as their official de jure
regime, and their actual de facto exchange rate practices.
(Reinhart and Rogoff 2004)
– de jure: what the countries say they do
– de facto: what they actually do
• Countries listed in the official IMF classification as managed
floating, 53 percent turned out to have de facto pegs, crawls or
narrow bands
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
De jure vs De facto
• Many countries that say they float, in fact intervene heavily in the foreign exchange market
– “Fear of floating” - Calvo & Reinhart (2001)
• Many countries that say they fix, in fact devalue when trouble arises.
– “The mirage of fixed exchange rates” - Obstfeld & Rogoff (1995).
• Many countries that say they target a basket of major currencies in fact fiddle with the weights.
– Parameters kept secret - Frankel, Schmukler & Servén (2000).
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016 9
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
One statistical approach
• One statistical approach to ascertaining de facto regimes:
– Var (exchange rate) vs.
– Var (reserves).
• Calvo & Reinhart (2002)
– note that many countries that de jure say they float in fact have a lower Var (Δe) relative to Var (ΔRes) than many that say they fix !
• Levy-Yeyati & Sturzenegger (2005)
– classify all countries based on variability of Δe vs. variability of
ΔRes.
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Discordances
• That de facto schemes to classify exchange rate regimes differ
from the IMF’s previous de jure classification is by now well-
known.
• It is less well-known that the de facto schemes also do not
agree with each other !
11
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Correlations Among Regime Classification
Schemes
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IMF GGW LY-S R-R
IMF 1.00
(100.0)
GGW 0.60 (55.1)
1.00 (100.0)
LY-S 0.28 (41.0)
0.13 (35.3)
1.00 (100.0)
R-R 0.33
(55.1) 0.34 (35.2)
0.41 (45.3)
1.00 (100.0)
(Frequency of outright coincidence, in %, given in parenthesis.)
GGW =Ghosh, Gulde & Wolf. LY-S = Levy-Yeyati & Sturzenegger. R-R =
Reinhart & Rogoff
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Roadmap
13
1. Classifying countries by exchange rate regime
2. Advantages of fixed rates/floating rates
3. Which regime dominates?
4. From the Trilemma to the dilemma?
5. The pseudo “currency war”
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Advantages of fixed rates
• 1) Encourage trade <= lower exchange risk.
• True, in theory, can hedge risk. But costs of hedging: missing
markets, transactions costs, and risk premia.
• Empirical: Exchange rate volatility ↑ => trade ↓ ?
– Time-series evidence showed little effect. But more in:
– Cross-section evidence, especially small & less developed countries
– Currency unions: Rose (2000).
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
The Rose finding
• Rose (2000) -- the boost to bilateral trade from currency unions is:
– significant,
– ≈ FTAs, &
– larger (2- or 3-fold) than had been previously thought.
• Many others have advanced critiques of Rose research.
– Re: sheer magnitude
• endogeneity,
• small countries,
• missing variables.
– Estimated magnitudes are often smaller, but the basic finding
has withstood perturbations and replications remarkably well. ii/
• Some developing countries seeking regional integration
talk of following Europe’s lead, though plans merit skepticism.
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Advantages of fixed rates
• 2) Encourage investment
– cut currency premium out of interest rates
• 3) Provide nominal anchor for monetary policy
– Barro-Gordon model of time-consistent inflation-fighting
– But which anchor? Exchange rate target vs. Alternatives
• 4) Avoid competitive depreciation (“currency wars”)
• 5) Avoid speculative bubbles that afflict floating
• 6) External debt in hard currencies less risky
– original sin of emerging countries
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Advantages of floating rates
• Monetary independence
• Automatic adjustment to trade shocks
• Retain seigniorage
• Retain Lender of Last Resort ability
• Avoiding crashes that hit pegged rates
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Roadmap
18
1. Classifying countries by exchange rate regime
2. Advantages of fixed rates/floating rates
3. Which regime dominates?
4. From the Trilemma to the dilemma?
5. The pseudo “currency war”
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Which regime dominates?
• Performance by category is inconclusive
• To over-simplify findings of 3 studies:
– Ghosh, Gulde & Wolf: hard pegs work best
– Sturzenegger & Levy-Yeyati: floats perform best
– Reinhart-Rogoff: limited flexibility is best !
• Why the different answers?
– The de facto schemes do not correspond to each other.
– Conditioning factors (beyond, e.g., rich vs. poor).
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy
Which category
experienced the
most rapid growth?
Levy-Yeyati & Sturzenegger:
floating
Reinhart & Rogoff:
limited flexibility
Ghosh, Gulde
& Wolf:
currency boards
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy
Levy-Yeyati & Sturzenegger (2001): floats work best.
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Which dominates?
• No one exchange rate regime is right for all countries or all times
– Answer depends on circumstances, of course.
• Traditional criteria for choosing - Optimum Currency Area.
– Focus is on trade and stabilization of business cycle.
• 1990s criteria for choosing –
– Focus is on financial markets and stabilization of speculation.
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Optimum Currency Area Theory (OCA)
• Broad definition:
– An optimum currency area is a region that should have its own
currency and own monetary policy.
• This definition can be given more content:
– a region that is neither so small & open that it would be better off
pegging its currency to a neighbor, nor so large & heterogenous that
it would be better off splitting into sub-regions with different
currencies.
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
OCA criteria
• Small size and openness
– because then advantages of fixing are large.
• Symmetry of shocks
– because then giving up monetary independence is a small loss.
• Labor mobility
– because then it is possible to adjust to shocks even without ability to
expand money, cut interest rates or devalue.
• Fiscal transfers in a federal system
– because then consumption is cushioned in a downturn
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
The endogeneity of the OCA criteria
• Bilateral trade responds positively to currency union
– Rose (2000).
• A country pair’s cyclical correlation rises too
– (rather than falling, as under Eichengreen-Krugman hypothesis).
• Implication: members of a monetary union may meet OCA
criteria better ex post than ex ante
– Frankel & Rose (1996).
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Popularity in 1990s of
institutionally-fixed corner
• currency boards
– (e.g., Hong Kong, 1983- ; Lithuania, 1994- ; Argentina, 1991-2001;
Bulgaria, 1997- ; Estonia 1992-2011; Bosnia, 1998- ; …)
• dollarization
– (e.g, Panama, El Salvador, Ecuador)
• monetary union
– (e.g., EMU, 1999)
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
1990’s criteria for the firm-fix corner
• Regarding credibility:
– a desperate need to import monetary stability, due to:
• history of hyperinflation,
• absence of credible public institutions,
• location in a dangerous neighborhood, or
• large exposure to nervous international investors
• A desire for close integration with a particular neighbor or trading
partner
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Level of financial development
• Aghion, Bacchetta, Ranciere & Rogoff (2005)
– Fixed rates are better for countries at low levels of financial
development: markets are thin.
When financial markets develop,
exchange flexibility becomes more attractive.
– Estimated threshold: Private Credit/GDP > 40%.
• Husain, Mody & Rogoff (2005)
– For richer & more financially developed countries,
flexible rates work better
• in the sense of being more durable &
• delivering higher growth without inflation.
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
External shocks
• An old wisdom regarding the source of shocks:
– Fixed rates work best if shocks are mostly internal demand shocks --
especially monetary;
– Floating rates work best if shocks tend to be real shocks -- especially
external terms of trade.
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Intermediate regimes
• target zone (band)
– Krugman-ERM type (with nominal anchor)
– Bergsten-Williamson type (FEER adjusted automatically)
• basket peg
– weights can be either transparent or secret
• crawling peg
– pre-announced (e.g., tablita)
– indexed (to fix real exchange rate)
• adjustable peg
– escape clause, e.g., contingent on terms of trade or reserve loss)
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
The Corners Hypothesis
• The hypothesis:
– “Countries are, or should be, abandoning intermediate regimes like
target zones and moving to either one corner or the other: rigid peg
or free float”.
• Origins:
– 1992-93 ERM crises -- Eichengreen (1994)
– Late-90’s crises in emerging markets – Fischer (2001).
• But the pendulum swung back,
– from 61% of IMF staff in 2002, to 0% in 2010.
– Many developing countries follow intermediate exchange rate
regimes.
– The theoretical rationale for the corners hypothesis never was clear
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Managed float
(“leaning against the wind”):
• Turkey’s central bank buys lira when it depreciates, and sells
when it is appreciates.
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Roadmap
33
1. Classifying countries by exchange rate regime
2. Advantages of fixed rates/floating rates
3. Which regime dominates?
4. From the Trilemma to the dilemma?
5. The pseudo “currency war”
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
The impossible Trinity
• A country must give up one of three goals:
– Exchange rate stability (by Hard Peg)
– Monetary Independence
– Perfect Mobility of capital (absence of capital control)
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
The impossible Trinity
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
From the Trilemma to the Dilemma
• World Financial integration lead to a global financial cycle (Rey,
2013)
– Dependent of the US monetary policy (and EMU)
– Cycles of risk aversion (panic/euphoria)
• No more autonomy of local monetary policies (even with foating)
• The need of capital controls
• The Dilemma
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Independent
Monetary Policy
Perfect Mobility of
capital
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Also for the Fed
• The Fed is also attentive to developmenet in the rest of the World
(especially ECB)
– 2014-2015: Accomodative MoPo by the ECB with QE
– Rise of the dollar
– The fed will normalize (rise interest rates) later
– See also Greexit risk
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Causality of interest rates variations
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Roadmap
39
1. Classifying countries by exchange rate regime
2. Advantages of fixed rates/floating rates
3. Which regime dominates?
4. From the Trilemma to the dilemma?
5. The pseudo “currency war”
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
The 1920s and 1930s currency war
• The seminal event:
– The return of the French franc to the gold standard at a considerably
depreciated level in 1926
– To restore Trade surplus that leads to considerable gold inflow from
other countries into France
• Then a cascade of devaluations
– Australia,
– Dutch East Indies (now Indonesia), Finland, Brazil, Poland, Canada
and Argentina
– in 1929 Uruguay, Argentina and Brazil
– United Kingdom (September 19, 1931)
– In 1931, 17 countries left the gold standard and/or substantially
devalued their currencies.
– In 1932 and early 1933, eleven more countries followed. From April
1933 to January 1934, the U.S. finally devalued the dollar by 59%
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
The pseudo « currency war »
• In 2010, The Brazilian Finance Minsiter claims « We are in the
mids of an international currency war »
– After a 10 month rise of the real against the dollar
– The real: one of the major overvalued major currency (according to
Goldman Sachs)
– Threatens competitiveness then problems to export
• The context:
– Strong accomodative monetary policiy by the Fed (ZIRP + QE)
– Leads to a low and flat yield curve
• But not a « currency war »
– Just collateral effects with the Fed fighting internal disequilibria
– High unemployment (low output gap) and deflation risk
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
The pseudo « currency war »
• Few years later (2013):
– the inverse problem
– When the Fed wants to taper
• Will continue in 2015 and 2016 with the Fed rising interest rates
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
• Emerging pseudo-crises (Spring-Summer 2013 on the Taper
tantrum)
Remember Stylized facts
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0,0%
-0,3%
-0,6%
-1,0%
-1,2%
-1,3%
-1,5%
-2,6%
-3,0%
-3,8%
-4,0%
-4,5%
-4,7%
-4,8%
-4,9%
-5,1%
-6,0%
-6,3%
-6,8%
-8,5%
-10,0%
-10,4%
-11,6%
-13,1%
-14,6%
-16% -14% -12% -10% -8% -6% -4% -2% 0%
SingaporeRomaniaJapanSwedenPolandCanadaNew ZealandIcelandColombiaNorwayAlgeriaRussiaPeruPhilippinesMalaysiaChileArgentinaMexicoThailandSouth AfricaAustraliaBrazilTurkeyIndonesiaIndia
May-July 2013 XR depreciations
Sources: BIS, monthly data from 1994 to 2015. Computations by the author.
® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Remember Stylized facts
• What moves FX markets?
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
Remember
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® 2009 Pearson Education France
transparents traduits par Vincent Dropsy International Finance –
Christophe BOUCHER – 2015/2016
See you next week….
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